Mar. 27 – China is about to become a great market for international businesses to sell to. That’s quite a statement, and I can recall similar proclamations being bandied about 20 years ago during the early days of Deng Xiaoping’s reforms, and then 10 years later when China eventually joined the WTO. Yet, as many a wise man noted – unless you were in the chopstick business, there weren’t actually a whole bunch of affluent Chinese looking to buy goods and services. That is now changing. But why?

Sir William Arthur Lewis, Nobel Prize for Economics, 1979.

Let me introduce you to Arthur Lewis. Lewis was an American economist, born in 1915, who won a Nobel Prize in his field in 1979. One of his theories, now known as the “Lewisian turning point,” was written in 1954 and titled “Economic Development with Unlimited Supplies of Labor.” In it, he lays out the economic principles that a “capitalist” sector develops by taking labor from a non-capitalist backward “subsistence” sector. At an early stage of development, there would be an “unlimited” supply of labor available from the subsistence economy which means that the capitalist sector can expand without the need to raise wages. This results in higher returns to capital which are then reinvested in further capital accumulation. In turn, the increase in the capital stock leads the “capitalists” to expand employment by drawing further labor from the subsistence sector. Given the assumptions of the model (for example, that the profits are reinvested and that capital accumulation does not substitute for skilled labor in production), the process becomes self-sustaining and leads to modernization and economic development.

The point at which the excess labor in the subsistence sector is fully absorbed into the modern sector, and where further capital accumulation begins to increase wages, is called the “Lewisian turning point.” This is the point that China has reached now.

China’s own development has mirrored the scenario predicted by Lewis and the result has been a shift in China from 20 years ago, when it had a large, young and available workforce with an average age of 23, to today’s more mature workforce with an average age of 37. Back some 20 years ago, the typical male worker may have been interested in having a couple of beers, smoking a few cigarettes and chasing girls. Today, he is married, has a child, a mortgage and both sets of parents as dependents. Simply put – today’s worker in China needs to have money in his pocket.

This is borne out by China’s government reacting to this shift by steadily increasing salaries, increasing welfare payments, and ensuring that he can afford to support the rest of his family. In short, China is developing a middle class. Estimates vary, but this is generally reckoned to be between 200 million and 250 million with middle class income to Chinese standards. When holding middle class income to U.S. standards, this figure is reduced to a lower, yet still impressive, 80 million.

What’s more impressive, however, is that the middle class is set to grow dramatically – McKinsey estimates that this figure will double by 2020. This means that the days of “cheap China” – when the world went to the country to manufacture cheap goods and sell elsewhere – are coming to a close. In its place has emerged a wealthy middle class of consumers, now both willing, able and financially secure enough to buy goods and services. If there was ever a time to reassess the China market as a viable destination for international businesses to sell to, that time is now.

But what about that cheap manufacturing? Conveniently, the average age of a worker in India today is the same as that in China 20 years ago: 23. The only difference between China then and India today is that India starts it’s ascent towards the “Lewisian turning point” with an existing middle class of 200 million to 250 million – curiously the same as China’s today.

The next two decades will see China emerge as a significant consumer market, and the impact of this is just beginning to be realized. To get into that, foreign companies need to act now to get in ahead of the competition. I already outlined the initial strategic steps – trademark registration – in yesterday’s article. We will also see a shift in India. Globally inexpensive products labeled “Made in China” will shift to “Made in India,” and Washington will soon complain about the Indian-American trade imbalance, and probably also have concerns over the U.S dollar-rupee exchange rate. All this will come to pass – the demographics, population, and economic theories all point to it being so.

A fascinating and recommended account of China’s shifting demographics and what this means – just released and available on Amazon.

Doing Business in ChinaOur 156-page definitive guide to the fastest growing economy in the world, providing a thorough and in-depth analysis of China, its history, key demographics and overviews of the major cities, provinces and autonomous regions highlighting business opportunities and infrastructure in place in each region. A comprehensive guide to investing in the country is also included with information on FDI trends, business establishment procedures, economic zone information, and labor and tax considerations.

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4 Responses

I won’t say that China does not have great future potential, but you may ask yourself why FDI is currently slowing down significantly. Besides, according to a recent McKinsey report only a minority (2% = about 4,26 million households of the Chinese urban population) earn more than US$ 34.000,- per year. That number is likely to rise in the future, but it will remain a minority. According to the same report, the big majority currently earns between US$ 6k – 16k, just enough to cover their basic needs. Issues like IPR and RMB repatriation are still (huge) bottlenecks for many foreign companies, let alone the inefficiency / non-transparancy of the legal and political system.

China has to change their economic model from (low cost) production and export based to (internal) consumption based, since export driven growth figures of 7 – 10% are simply not sustainable given the fact that developed economies in Europe and the USA have other priorities at the moment. If they don’t it may lead to unemployment and that holds the risk of social unrest. In the West consumer markets are changing as well due to the economic situation. In other words: China has no other choice than to stimulate their own internal economy.

And then you have the demographics. If one thing is for sure about China, then it is the rapidly ageing population (a mayor difference between China an India). What will be impact of that on future economic development?

The impact of an aging population is already being felt via increases in wage costs and welfare. That puts more money in the hands of the Chinese consumer – which is why US exports to China just hit USD100 billion for the first time – illustrating your point about China changing to a consumer based society. Japan also aged rapidly in the 1980’s.
In terms of unemployment, China’s labor pool is shrinking, and automation will also eat away at the size of the available workforce. But it’ll be the unskilled workers who will face possible issues – one reason why the minimum wage level and mandatory welfare costs for this sector of the population has risen so dramatically.
As for 7-8% GDP growth slowing – although it’s an easy statistic to trot out, you simply can’t keep a high positive growth rate for ever, it becomes the law of diminishing returns as each year your fiscal base expands. 7-8% in China is a pretty good rate and with an increasing middle class growth the signs are there that China at last is developing into a sustainable consumer market. It’s taken 25 years which is niot bad considering it has 1.3 billion people.
Next to follow the development curve? India.
Thanks
Chris

Thanks for your comment Chris. The mayor difference between Japan and China in terms of ageing is the fact that Japan grew old after they got rich (with a large young population), while China is the other way around.

What I also find troublesome is the reliability of the data, but that’s a different topic.

@Marcel – ah yes – the reliability of Chinese data. Good point. To some extent we’re all firing somewhat in the dark with a large dose of educated guesswork to assist, I don’t dispute that. Thanks – Chris